There are a couple of things about the article I find most useful. The first is that they seem less afraid of triggering a Credit Event and some even think it could be a good thing. We have been arguing that for months and months.

This article estimates that only about €100 billion of Greek bonds are actually in hands that will follow the IIF recommendations. It is only an estimate, and doesn’t mean that some non IIF members won’t go along, but it also doesn’t ensure that even all the IIF members will.

The negotiations are getting tricky (actually they have always been tricky, it’s just that until recently no one was actually negotiating). The IMF seems insistent that they won’t provide new money without a high participation rate in an exchange with worse terms than many thought. There are questions about whether the ECB should participate or not.

I have seen a range of estimates of what price the “new bonds” would trade at. Even assuming 100% participation for the €206 billion of bonds held by non-priority entities the Greek debt situation will be bad. The goal of 120% Debt to GDP in 2020 seems a long way off especially as the economy seems to be getting worse rather than better. Even with the plan, debt to gdp would rise again to well above 120% before it begins the theoretical decline to 120%. About the highest price estimate I’ve seen for new bonds (with principal protection from the EFSF) is about 75% of par. The lowest is about 25%. The more bonds that are exchanged, the higher the value should be, but realistically I think something around 50% to 60% of par is about right.

So, if you own €100 million of Greek bonds, you will exchange them for €50 million of new bonds, that will likely have a value of about €25 million. Depending on which bonds you own, you could sell those bonds in the market today for about €25 million. What you are getting if you agree to the deal is becoming clear, so investors need to compare that to what they might get if they don’t agree.

Basis package holders will continue to want to hold out. This is a small group, I’m guessing only about $2 billion (total Net CDS is down to only $3.2 billion). The value of the CDS contract (currently 63 points up front) will decrease with a high participation rate. The basis package holders will want to hold onto their bonds, as deciding to exchange and holding on to the CDS is likely a losing proposition.

Short dated bond holders (next 6 months) will be tempted not to exchange. If a deal gets announced and the IMF gives the next slug of money, it will be awkward for them to go ahead with “selective default” where they pay the ECB and other “public” holders out at par but not banks, insurance companies, and hedge funds.

The ECB’s Greek bond holdings are very interesting. They are adamant that they won’t participate. That has been the line all along, but I’m sure they aren’t happy that the IMF is pushing. It does raise some questions about the SMP. Bonds held by the ECB as part of the SMP have no special protections and are not legally nor structurally senior, yet they are being treated that way. This effective subordination of non ECB holders may weigh on the back of investor minds. Until now, the ECB’s purchases of bonds have been rewarded by the market with increased risk taking, but if every purchase is subordinating non ECB held debt, the enthusiasm may decrease as you have to balance the benefits of the ECB purchases with the fact that you are being crammed down. If the ECB takes a loss it could be done in a constructive way (immediate support from Germany, France, and others, to provide fresh injections into the ECB with no complaints), or the losses could be taken in some bizarre fashion with off-market trades to the EFSF or a lot of bickering from politicians about why they shouldn’t provide support for ECB losses.

Portugal and the LTRO

The Portuguese debt problem is much smaller than that of Greece, but it should be attracting more attention. The entire EU community has stated over and over that Portugal is not Greece, and PSI is going to be unique to Greece. They can say that, but clearly the market doesn’t believe it.

Source: Bloomberg

There are a couple of key points that this graph highlights. The fact that the 5 year bonds hit a new low is important. The market is clearly not buying into the rhetoric that only Greece will default (or haircut, or PSI, or restructure, or whatever euphemism they want to use).

Separately, this graph may be the best example of what LTRO has done. There were 3 earlier summits or announcements or grand plans. In each case, the 2 year bonds and 5 year bonds moved relatively in line. They both jumped higher, then leaked lower. That seems to have changed with LTRO. The 2 year bonds (covered by the LTRO maturity) performed much better than the 5 year bond. We didn’t see the 5 year bond participate in the rally to the same extent that the 2 year did. That would make sense as there was less selling pressure if not outright purchases on the back of LTRO. But now, the 2 year is starting to follow the 5 year down. Even LTRO is not enough to keep the 2 year bonds propped up.

The 5 year Portuguese bond shows that the market has no faith that Greece will be a unique situation, and the 2 year bond is showing that LTRO may be useful, but it doesn’t trump actual risk. Watch both of these closely.